Global Funds Still Cautious on China Bonds, Despite Opening Up

CHINA - For all the efforts to make China’s bonds more accessible to foreigners this year, some global funds are reluctant to own them.

Active money managers like Amundi and BlueBay are cautious on China’s government debt amid concern over liquidity, capital controls and hedging. While foreigners own just a fraction of the world’s second largest bond market, their opinion may soon hold a little more weight as FTSE Russell is expected to include the bonds in its flagship index.

China recently scrapped investment limits for foreigners as it seeks to encourage more inflows into its capital markets and increase the yuan’s global use. Bloomberg Barclays started a phased inclusion of some Chinese sovereign debt into its benchmark indexes in April, while JPMorgan Chase & Co. said it will do so from February. FTSE Russell will announce its decision Friday morning Hong Kong time.

Thin liquidity -- commercial banks that dominate China’s fixed-income market tend to buy and hold bonds rather than trade -- and a shortage of hedging choices are deterrents. Controls on outflows also mean foreigners face difficulty withdrawing cash. Even as the central bank has signaled a preference for a steady yuan, concerns about potential outsized moves in the currency linger.

While international investors have increased their holdings to 2 trillion yuan ($284 billion) as of August, that’s just 2% of China’s 94 trillion yuan market. Foreigners bought around 100 million yuan of Chinese bonds last month, compared with 62 billion yuan in July. The amount was the least since February when they were net sellers.

China’s 10-year government bond yield has traded near 3.1% over the past month as the central bank refrained from aggressive stimulus despite slowing economic growth. Worries about credit risks and increasing supply of special government notes have also weighed on sentiment. The yield was little changed at 3.12% on Wednesday.

To be sure, as more global bond yields turn negative, China’s roughly 3% returns may attract more overseas interest. Ten-year sovereign notes still offer about 1.4 percentage points more yield than their U.S. counterparts. China’s slowing economic growth, “contained inflation,” and aging population will boost demand for its bonds in the long run, said Cary Yeung, head of greater China debt at Pictet Asset Management.